Intrigued by government contracting opportunities? What you should look at before you leap

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1 Intrigued by government contracting opportunities? What you should look at before you leap With contracts totaling more than $5 trillion in the past decade alone, the US government is the world s largest buyer of goods and services. Selling to the federal government, given its vast spending power, diverse procurement needs, and consistent year-to-year demand, can offer significant revenue and growth opportunities across the industry spectrum. While businesses often enter into such contracts enticed by the additional revenue stream, they frequently overlook associated risks that can adversely affect the entity long after the revenue flows in and the contract is complete. The rewards can be rich: As the world s largest consumer, the United States boasts significant spending power and faces substantial needs. Companies can find numerous opportunities to turn government contracting into a profitable piece of their portfolio. The availability of additional revenue is high, including lucrative follow-on opportunities. Contracting with the government enables companies to further develop their business through research and development (R&D), with the government covering certain independent research and development costs. Government contracting can be a profitable business, with the potential to provide stable income for multiple years. Companies can also benefit from the increased credibility and higher profile that can be associated with doing work with the government. The positive cash flow and reputational boost can help position companies to move strongly into additional future business ventures.

2 Compliance Requirements Financial Investment But the risks can be challenging: Companies that wish to become successful government contractors should make an up-front initial investment in improvements to people, process, and technology to prepare for the significant compliance responsibilities that come with federal contracts. And, despite this initial investment, there is no guarantee of obtaining a contract. Contracting with the government may require a full disclosure of costs, not only for programs with the government, but also for total costs incurred by the company. This can result in additional government agency scrutiny and audits of all facets of the business, particularly from the Defense Contract Audit Agency (DCAA) and the Defense Contract Management Agency (DCMA). Companies often are unaware of intellectual property laws pertaining to the R&D they create. If not properly mitigated, this can enable the government to turn R&D products over to competitors. Claiming ignorance is not a suitable defense for non-compliance. It s important that companies understand the regulations associated with government contracting and the implications that stem from noncompliance. The window of liability is greater than many business leaders anticipate, requiring additional monies to properly prepare and prevent issues that can arise long after the contract is complete and revenue has been collected. Among the central compliance considerations is the DCAA s right to perform an audit throughout the contracting life cycle, beginning with the proposal stage and continuing several years after the completion of the contract. Because of this large audit window, companies often have to repay monies for years after an audit finds that they received revenue for disallowed costs, as well as additional monetary penalties related to those costs. Approaches to government contracting As depicted in the chart, companies can pursue government contracting through multiple avenues, with varying degrees of associated risk, depending on the type of contracts they engage in. Contracting through Federal Acquisition Regulation (FAR) Part 12, Acquisition of Commercial Items and the Federal Award Schedule, which includes both General Services Administration (GSA) and Veteran Affairs contracts, generally carries the least amount of risk and requires less capital expenditure. On the other hand, a FAR Part 15, Contracting Through Negotiation, tends to have greater risk and requires companies to invest heavily in people, process, and technology to mitigate it. High High Low FAR Part 12 Commercial Item FAR Part 38 Federal Supply Schedule FAR Part 15 FFP No Cost or Pricing Data Required FAR Part 15 Cost or Pricing Data Required FAR Part 15 CAS Covered Low Government Contracting 2

3 These rules are based on the government s responsibility to US taxpayers to obtain items at a fair and reasonable price when it procures goods or services. When the government procures using FAR Part 12, it relies on the commercial market to achieve the fair and reasonable price. When an item doesn t have a commercial market, the government procures under FAR Part 15 contracting, where it can view all cost and profit information to confirm that taxpayers are paying a fair price. From the contractor s perspective, contracting through FAR Part 12 presents the least amount of risk, as prices are set by the market, and therefore, the government does not request cost or pricing information. The government may, however, request proof that the item being sold is a commercial item as defined in FAR As we move to FAR Part 38 contracting, involving the General Services Administration and the Department of Veterans Affairs, the risks increase slightly, as pricing provided to the government requires monitoring, and all monies received require tracking, to enable Industrial Funding Fee (IFF) payment back to the government. FAR Part 15: A closer look Although companies have the flexibility to conduct negotiations for both price and procedure under FAR Part 15, this avenue can be time consuming, resource intensive, and require an experienced team, given the many requirements. FAR Part 15 contracting falls under three main types of procurements: FAR Part 15, where no cost or pricing data is required FAR Part 15, where cost or pricing data is required Cost Accounting Standard (CAS) covered contract awards FAR Part 15 no cost or pricing required will generally occur in cases where the item is not a commercial item as defined earlier, but where adequate competition provides the government with a fair and reasonable price through competitive forces. While the prices will still be negotiable, cost or pricing data generally will not be required. The government does have the right to request other than cost or pricing data, again defined in FAR 2.101, so the risk related to determining a fair and reasonable price lies in the contractor s ability to provide cost-realism analysis or other data the government might request. In FAR Part 15 contracting, where cost or pricing is required, but companies are not CAS covered, the government has audit rights to review the cost or price buildup. This requires companies to disclose all cost and profit projections, as well as to allow the government the right to audit the cost or pricing data. In these cases, a company will likely be required to sign a Truth in Negotiations Act (TINA) certification advising the government that the contractor has disclosed all the supporting information used to back-up the cost data. If it s later found that the company had other information that was not disclosed, such as an updated quote from a vendor that lowered the cost estimate, the government can terminate the contract for default and pursue legal action against the company and the individual who signed the TINA certification. CAS covered FAR Part 15 contracting presents the greatest amount of risk. In addition to the other requirements noted, it also requires contractors to file a Disclosure Statement explaining how they plan to propose, accumulate, and report all costs incurred in the business; and it opens the company to DCAA/DCMA/government agency audits on the 19 CAS standards. This type of contracting carries the highest risk of non-compliance and should be entered into only after the company has the right people, process, and technology in place. The importance of business transformation steps A recent court case demonstrates the significant monetary impact that failure to prepare properly for government contracting can have on a business, its billfold, and brand. In this case, the contractor requested the payment of more than $2 million in bond premiums earlier than is allowed by law. As a result, it was required to pay treble damages of more than $7 million. The business likely would have been reimbursed for the bond premium payments, but it lacked the right people, process, and technology to manage the requested payment appropriately. When companies decide to enter into government contracting, they should have their people, process, and technology in a state that can support the level of contracting that business leaders plan to take on, and the three phases should be considered in concert with one another. Great technology likely will do little good if the company lacks the right staff and processes to manage it effectively. Likewise, a company can have a system that precludes strong employees from completing their work. Each of the three steps is a vital piece of the puzzle and unlikely to function effectively in isolation. Government Contracting 3

4 The right stuff People Proper staff deployment is critical to successful government contracting. Companies anticipating such a transformation should identify the individuals who will be integral in supporting the transformation, provide them with appropriate training, and expand their knowledge of government contract compliance. Seeking knowledgeable people to assist in this transformation is critical and should include those familiar with compliance requirements and technology solutions and requirements. Companies also should line up appropriate representation from the various lines of business to achieve a transformation that captures the overall business culture, strategy, and objectives. When determining the appropriate team, business leaders should think not only about tenure and knowledge of the business, but also about how well the team will be able to disseminate its tools and training to the rest of the company. As companies move more deeply into government contracting, they ll want to establish a more robust compliance department. The structuring and responsibilities in the compliance department will vary, depending on corporate structure and capabilities. Companies may have to transfer or hire individuals onto the team to fulfill specialized functions such as compliance, finance, IT, and business development. For example, if a company participates under FAR Part 12, a basic understanding of government contracting can be sufficient and typically can be managed by one or two individuals in addition to their day-to-day responsibilities. On the other hand, FAR Part 15 contracting should be managed by an established compliance department, generally composed of several individuals who can handle a multitude of compliance requirements. Companies moving into government contracting should keep these steps top of mind: A compliance department and/or finance department should understand and report on contract funding limits, manage the issuance of monthly reports, compile Incurred Cost Submissions (ICS) annually, and monitor compliance with the 19 CAS requirements. The existing contracts and subcontracts/procurement department should be strengthened. New procurement regulations should be understood and training should be conducted to educate the workforce. The estimating department should be trained to understand government procurement regulations. Many companies establish a group specifically trained to propose on government contracts, so that the appropriate requirements are understood and properly proposed. Successful companies plan for the type of government work they will be soliciting and build their human capital resources to match the potential demand, positioning them to boost their returns. Process Process may be the most important consideration in a contractor s bid to realize potential profits and increase future competitiveness. Before a company can define appropriate processes, leadership should determine the organizational structure needed to support the business needs and the additional compliance requirements that will come along with the level of contracting the company plans to perform. Leadership should determine whether the company will use a decentralized or centralized management structure, and whether administrative support, such as human resources (HR), IT, contracts, and finance, will be performed at each location or be brought in as a shared services. Another consideration for organizational design involves the degree to which the business is willing to open up to an DCAA/DCMA/government agency audit; as noted earlier, CAS covered FAR Part 15 contracting requires the company to allow full audit rights for all costs included in proposals and contracts. Companies can be organized in ways that can enable parts of the business not performing government work to operate without additional compliance requirements. Organizational design needs to be considered long before proposing on your first FAR Part 15 contract. With well-designed processes that are documented for future replication, you ll have fewer variables between requirements and deliverables and, therefore, likely fewer mistakes. If companies can take time to properly design their processes and formulate opinions and theories to support their actions, they likely can be more consistent and better positioned to meet the government s demands. Government Contracting 4

5 Business processes should be defined based on the company s business pillars, including such functions as procurement, finance, contracts, billing, and HR. While each pillar will require specific processes, the strategy should be approached at the corporate level to promote coordination. Overall, the business requirements should be defined at the corporate level to take into account the full gamut of processes. For example, with regard to the finance function, a company should establish processes for activities throughout the contracting life cycle, from capture through contract closeout. Will finance primarily be responsible for preparing cost estimates, or will you have a separate pricing organization to assist in this? How will costs be captured, allocated, and reported on during contract performance? This goes beyond the operation of the accounting system to include how costs will be entered into the accounting system; whether cost allocations are automated in the accounting system or performed manually, and the like; and how contracts will be closed out. Finance is generally relied upon to develop and monitor indirect cost rates, to develop forward pricing rate agreements, and to prepare and submit incurred cost submissions, in addition to many more monitoring and reporting requirements. Each of these can individually pose a threat to success, absent adequate processes and support. Take, for example, the ICS process. Contractors performing work on cost-reimbursable contracts are required to submit an incurred cost proposal within six months of the end of their fiscal year. Many smaller companies without dedicated compliance staff rely on members of the finance staff to prepare this submission in addition to their regular duties. Due to turnover and the overlapping of the second-quarter close and the ICS submittal date, this activity may be delegated to a different person each year. As a result, significant variance in ICS submissions can occur year over year something that can easily be spotted during a DCAA audit, potentially inviting a higher risk rating, and likely resulting in more intense scrutiny. The DCAA 2011 Report to Congress suggests that the agency is nearly three years behind in reviewing and auditing ICSs; contractors who submitted ICSs by June 30, 2012 can reasonably expect that their audits won t take place until early 2015, a full four years after the underlying costs were incurred. Inadequate processes can cause future issues for companies that lack adequate processes to support compliance requirements. Companies that have transparency in their methods and that remain consistent over time tend to have the most success in contracting with the government. Transparency and consistency can help enhance the company s stature and elevate its relationship with the government, likely improving its chances of winning future work. Technology Technology can be an important differentiating factor among competitors. Technology should be built upon strong people and well-designed processes to successfully reduce process times and mitigate contractor risk. Investing in the right amount of technology is crucial for prospective government contractors. Contractors that fail to tap appropriate technological resources can court on errors stemming from manual processes and may face greater challenges in meeting government reporting demands. At the same time, technology that is used ineffectively and below its capacity or that is used incorrectly can place a significant burden on the business and thwart efforts to contract with the government. Your technology investment should reflect the level of contracting you anticipate. For contracts performed under FAR Part 12, it s likely that you ll need to add little to existing systems, provided that they already support normal business processes. But companies moving toward Federal Supply Schedule and FAR Part 15 contracting will likely need to establish technology platforms that support the necessary reporting requirements. Federal Supply Schedule (FSS) contracts, for example, require companies to identify a tracking customer or group of customers as a base for their FSS pricing. The relationship between the prices charged to the government and the prices charged to the tracking customers should remain constant. If companies provide a discount to the tracking group, that same discount should also be provided to the government. Technology can be useful in identifying situations where the pricing for a company s tracking customers has changed. It also can alert the compliance department to necessary updates to the government s price list, enabling the company to proactively provide an equal discount to the government without risking contract termination for Government Contracting 5

6 default or incurring penalties. This can be especially important in decentralized organizations where, for example, a salesman in Portland discounts a product that is on an FSS that s monitored in Virginia. Under FAR Part 15, contractors need to be able to estimate, accumulate, and report costs at a consistent level, usually to at least the Contract Line Item Number (CLIN). Contractors typically need to provide financial reports on a monthly basis, showing total contract and CLIN spending, including all applicable allocated costs. Yet, many commercial systems are not designed or implemented to report at that level of detail. In addition to reporting requirements, the systems themselves may also be required to comply with applicable regulations. Accounting systems, for example, may need to comply with the Standard Form 1408 Pre-Award Accounting System Survey before the company can be awarded a cost-reimbursable contract. Similarly, the company s estimating systems may need to comply with Defense Federal Acquisition Regulation Supplement (DFARS) and requirements. You might also need to add systems such as the Earned Value Management System (EVMS), the Government Property System, and the like. Government resources The government provides a number of resources to help companies understand and manage risk, including the DCAA s website ( its Information for Contractors publication, which covers audit requirements and processes; and its Defense Contract Audit Manual (DCAM), which prescribes the auditing policies and procedures that guide DCAA personnel in the auditing techniques aligned with the DCAA mission. While the manual is written for DCAA auditors, it can also serve as a good tool for familiarizing contractors with the steps government auditors take when performing prescribed contract audits. The DCAA is responsible for financial oversight of government contracts to confirm that the Department of Defense (DOD) gets the best value for its dollar and to eliminate the waste and misuse of taxpayer money. DCAA s regulations don t apply solely to DOD contracts; the audit procedures and guidance interpretation pertain to all government contracts. Although the DCAA performs audits on all required DOD contracts, it can also be used by other agencies to conduct audits on additional agency contracts. By using and understanding these resources, companies can take proactive and preventative measures to limit their exposure and better prepare themselves for successful contracting with the government as a whole. Government contracting: An up-front strategy, not an afterthought Before deciding to contract with the US government, business leaders should analyze the associated risks and rewards with a clear understanding of where the corporate strategy is heading and how it might be affected by such a move. It s vital for business leaders to pursue contracting in a manner that aligns with business leaders long-term goals and to properly invest in people, process, and technology to mitigate potential risks. This can open the door to a successful bid to embrace the opportunities the proposed work can deliver and to establish enduring and mutually beneficial relationships with US government officials. Government Contracting 6

7 A special acknowledgment to the authors: Jim Nelson (312) Chris Ficke (646) To have a deeper discussion, please contact our specialists: Philip Koos (646) philip.koos@us.pwc.com John May (617) john.m.may@us.pwc.com Suzanne F Roske (602) suzanne.f.roske@us.pwc.com James Thomas (703) james.w.thomas@us.pwc.com 2013 PricewaterhouseCoopers LLP, a Delaware limited liability partnership. All rights reserved. refers to the US member firm, and may sometimes refer to the network. Each member firm is a separate legal entity. Please see for further details. This content is for general information purposes only, and should not be used as a substitute for consultation with professional advisors.